Prior to investing in real property in the United States, a foreign person should explore several tax, corporate and liability concerns. All too often, investors do not consider these issues until they are prepared to sell the property. Unfortunately, that may cause the investor to incur additional tax, expense or liability, which might have been avoided with the appropriate planning prior to purchase.
Foreign real property owners are subject to certain withholding requirements when selling their U.S. property. In a real estate transaction involving a foreign seller, the Foreign Investment in Real Property Tax Act (“FIRPTA”) requires ten percent of the gross sales price be withheld from the sale proceeds received at closing. This withholding is remitted to the Internal Revenue Service as a deposit on the income tax liability generated from the sale. When the actual income tax resulting from the sale is reported on the seller’s tax return, the withholding will be applied and the seller will either remit a sum to satisfy the outstanding balance or will receive a refund of any excessive withholding.
An exception to the withholding requirement applies to sales of real property where the sales price does not exceed $300,000 if the purchaser intends to make personal use of the property as a residence for at least fifty percent of the time the property is in use, for at least two consecutive years following the date of purchase. This exception is not available to business entities, trusts, or the sale of vacant land.
FIRPTA also applies to short sale transactions and may present hurdles in negotiations with the short sale lender. If a sale does not qualify for the above-referenced exception, the seller may take the necessary steps to apply to the IRS for a withholding certificate, which grants a reduction or elimination of the ten percent withholding requirement. Application and processing of a withholding certificate requires additional time and should be considered when negotiating the terms of a contract.
On the other side of the transaction, a foreign purchaser of real property should also consider the benefits of different forms of holding real estate. There are varying income and estate tax consequences for foreign individuals and foreign business entities holding, renting, transferring and selling U.S. real estate. These consequences depend on a number of factors, including the domicile of the owner, value of the property, and the income produced from the property. Each owner’s circumstances and goals should be evaluated to determine the most beneficial way to take title to real property. In general, holding title to real property in a foreign person’s individual name minimizes the income tax due when the property is sold. If the property is held for more than one year, the maximum tax due is 15% of the profit of the sale. If a US corporation owns the property, the tax rates upon sale vary, but are much higher. The benefit of owning the property in a US corporation is that the US estate tax may be eliminated when the foreign owner dies, whereas for an individual, the tax may be substantial.
The circumstances and outcomes vary widely. For any investor considering a purchase of US real property, it is strongly recommended that the foreign person consult with a US tax advisor experienced in this area of law to assist in structuring any transaction.
